In its twice-yearly report on the global economic outlook, the Organization for Economic Cooperation and Development (OECD) lowered its growth forecasts for the world's largest economies, declared that the euro zone is headed towards a recession, and cautioned that the global economic outlook has deteriorated significantly.
Contrary to what was expected earlier this year, the global economy is “not out of the woods”, Chief Economist Pier Carlo Padoan wrote in his introduction to the report. "The euro zone must urgently take stronger measures," Mr Padoan said. The euro area crisis represents the key risk to the world economy at present, with concerns about sovereign debt sustainability having become increasingly widespread.
The way to go about avoiding this risk is to firstly understand the euro zone problem in a direct manner. As succinctly stated by OECD and The Economist, “the problem [of the euro zone crisis] is fairly straightforward, the euro zone developed a balance-of-payments problem; some of the countries in the single currency accumulated large external debts. To service those debts, the deficit countries need to become surplus countries, which is difficult to do without the flexibility of a floating currency. The difficulty of adjustment has led markets to doubt the solvency of some institutions, and these doubts have, in the absence of a lender-of-last-resort, metastasised into a contagion that threatens to leave banks and sovereigns bankrupt.”
The euro zone has already entered a mild recession but much worse could follow unless policy makers take decisive action to get ahead of the market, the OECD said in a stark warning. "There is a risk to the euro, let's not deny that," Mr Padoan said. "But I would like also to say that there is a possibility of avoiding that risk." The report recommended the European Central Bank to cut rates and increase its purchases of government bonds in order to limit the cost of borrowing for governments.
Mr Padoan added that if major economic shocks such as the default of a euro zone member or the collapse of a big bank were avoided, then the global recovery would likely resume over the course of 2012.
US's Economic Woes
Additionally, the OECD expects the world's largest economy – the United States to grow by 2% in 2012, having forecast an expansion of 3.1% in May. It expects growth to pick up again to 2.5% in 2013. But without action in US Congress, the OECD projects that US economic growth would be barely measurable at 0.3% next year that will only improve to 1.3% in 2013.
The OECD also warned that continued troubles in Europe, along with spending cuts and tax increases set to take place following the failure to reach a deal by the US Congressional debt committee could push the US economy to the brink of recession.
"Another serious downside risk is that no action will be agreed upon to counter the pre-programmed fiscal tightening in the US, which could tip the economy into a recession that monetary policy can do little to counter," Mr Padoan said.
"The present situation is worse than in 2009," Mr Padoan said. "Trade was the driver of economic growth after the 2008 financial crisis, but now we're seeing risks of protectionism."
A sharp deterioration in the global economy would also harm Japan's prospects. Japan, the region’s second-biggest economy, risks seeing a spike in government bond yields unless it controls a debt load set to approach 230 percent of gross domestic product in 2013, the OECD said. The OECD thus advised Bank of Japan to respond to a spike in yields by improving on its plan to achieve a primary budget surplus by the end of the decade and expand asset purchases and fund-supply operations to bolster the economy.
“The delay in fiscal consolidation and the continuing rise in the public debt ratio compound the risk of a run-up in long- term interest rates,” the report said.
In response, Bank of Japan Governor Masaaki Shirakawa said current yen rises are driven by very high uncertainty over the global economic outlook due to Europe's sovereign debt crisis.
Mr Shirakawa also told parliament that he hopes the central bank's monetary easing, which aims to lower risk premium and longer-term interest rates, would have a "positive" effect on currency rates by keeping sharp yen rises in check.
Report: OECD Warns U.S. at Risk of Recession [The Wall Street Journal, 28 Nov 2011]
Report: OECD says Japan risks rise in long-term rates [Reuters, 28 Nov 2011]
Analysis: Who killed the euro zone? [The Economist, 28 Nov 2011]